No recessions, no recoveriesAggressive government policies and excess capital may have fundamentally changed economic and market cycles, Macquaries Viktor Shvets says. The economic cycles weve seen throughout history may be a thing of the past. That means no more deep recessions and no dramatic recoveries; the economy will almost always exist somewhere in between. Thats the theory of Viktor Shvets, head of global desk strategy at Macquarie Capital, who believes that most of the time, investors will reside in a world of twilight. > > What Im basically saying is that we no longer have recognizable economic or capital-market cycles, Shvets told MarketWatch. When did we actually have a real recession? When was the last time it actually happened? The answer is that you really have to go back to the 1850s to 1930s to see anything resembling a real recession. > > Shvets noted that in the 20 or so economic downturns that happened between the Civil War and the early 1950s, economic output shrank by about 20%. But in the recessions that have happened since the 1950s, the average output contraction was closer to 3%. He said that the one exception to this was the recession that was caused by the COVID-19 pandemic but that recession was also the shortest on record. > How did we get to this twilight world? > > So what happened? One major factor has been government and central-bank intervention. A turning point was the role the U.S. government, under President Franklin D. Roosevelts leadership, played in reshaping the economy during the New Deal era. Shvets quoted economist Peter Drucker in saying that the New Deal response to the Great Depression led people to believe that it was the governments job to manage the economic weather rather than the climate. > > In the past, the government would only step in when there was a massive, massive problem essentially, the whole economy was either freezing or overblowing the top. But since FDRs New Deal, that was no longer the case, Shvets said. In other words, the government started to manage weather. Every day has to be 70 or 80 degrees Fahrenheit; the occasional cloud is absolutely fine, but certainly no thunder and lightning, and certainly no floods. > > As a result, the economy gets a policy landing pad during recessions, meaning its fall is softened. But on the flip side, Shvets said that this leads to milder recoveries, as the economy doesnt build the robustness needed to get itself out of a recession. > > In addition to economic cycles, the government also manages capital-market cycles. > > For proof of this, Shvets pointed to the financialization of the economy, the depegging of the U.S. dollar to gold and the policies of past Federal Reserve chairs like Paul Volcker and his role in government debt, and Alan Greenspan and his synonymous Greenspan put. > > What started to happen is that we started taking risk out of the financial system. So the higher our leverage would become, the higher our exposure to asset prices would become, Shvets said. The policy makers, especially central banks, have become much more proactive. > > Central banks are not just conveyors and purveyors of trust; they increasingly act as market participants themselves, he added. And so the result is we no longer have conventional capital-market cycles. > > In addition to monetary policy, Shvets pointed out that communication policy is also a powerful tool the Fed has up its sleeve. Communication policy means that central banks can help dictate the flow of capital based on how they communicate to the markets. > > Investors see this in action all the time: Markets often react strongly when Federal Reserve Chair Jerome Powell holds a press conference, giving further weight to the idea that central banks have become active market participants. Shvets explained that communication policy is so effective because there is an abundance of capital. When there is extra money in the system, that helps cushion downturns, as money can come from elsewhere to help contain economic forest fires. > > We have a surplus of capital. If you have a surplus not deficiency of capital, than there is money for everything, he said. There is no need to tighten spreads; there is no need to stay to widen the spreads. All you need to do is to talk to the capital. > What should investors do with this information? > > A heavy hand by governments and central banks, as well as a surplus of capital, has led to an erosion of traditional economic and capital-market cycles. And when those cycles erode, it becomes harder to rely on traditional cycle signals. > > Recently, markets have seen a few recession indicators firing off. There was the inverted yield curve, a peak in the federal-funds rate and the triggering of the Sahm rule. However, those signals have yet to lead to a recession. In fact, recent U.S. economic data has shown relatively strong GDP and job growth. > > In a note for Macquarie Capital, Shvets wrote that investors may be better off ignoring most macroeconomic narratives whether thats people saying the U.S. dollar is doomed or that out-of-control spending implies higher rates. In Shvets twilight world, the way these narratives play out is never as drastic as theyre made out to be. Investors may be better off weathering the gentle storm. > > However, Shvets added that this environment may be ideal for a small basket of stocks to outperform the market whether thats FAANG, the Magnificent Seven, GRANOLAS or some new group of companies. He said he avoids themes like cyclicals and value stocks, and instead invests in companies that have circular drivers and the potential to increase productivity. > > Thats the investment strategy, but the components which go into that strategy changes over time, he said. In this world of twilight and in this world which is disrupted by the information age and financialization micro caps can become macro caps very quickly, and macro caps can become micro caps very quickly.